Where next for UK interest-rates? Will Martin Weale vote for a rise?

In an interview published by the Financial Times a member of the Monetary Policy Committee of the Bank of England broached the issue of higher official interest-rates in the UK. Here is the headline quote from the interview with the MPC’s Martin Weale.

Britain needs to start raising interest rates sooner rather than later if it wants to avoid sharp and painful increases in the future,

This tells us that Martin Weale was one of those who thought that the UK economy was “becoming more balanced” in the most recent MPC Minutes. He added:

“What I’m increasingly going to have to do as more capacity is used up is balance off my sense of the risk of waiting too long versus acting too soon.

“I very much can see risks both ways and ‘becoming more balanced’ means an increasing sense of having to balance and judge those risks.”

Actually he is tying himself up in knots here and by repeating the current central bank mantra that it is all down to spare capacity he makes matters even more opaque.

“I wouldn’t say that 0.9 had gone down to 0.7 or 0.6 but I think it’s fair to say there is less capacity than there was on the basis of the figures I looked at.”

He means 0.9% and 0.7% or 0.6% as an estimate of how much spare capacity there is in the UK economy. This poses several issues of which the most obvious is that with the current growth rate of the UK economy then, in my view, he is denying what is happening right now. Next we have the issue that at current growth rates the margin he estimates will be gone in the summer, which means that on his own logic he should have already voted for a base rate rise.

A theme of this blog is that concepts such as the “output gap” and “spare capacity” look objective but in fact are in the eye of the beholder and therefore extremely subjective. Of course that is why policy-makers and central bankers have zeroed in on them! It avoids having an explicit target such as an unemployment rate of 7% which is then embarrassing when you hit it and nothing changes in response.

By how much will the base rate rise?

Mr Weale said his definition of a “gradual” rate rise would involve the bank tightening by “no more than” 25 basis points (o.25%) a quarter.

Here he is much more on message as the Governor of the Bank of England Mark Carney regularly states that any rises will be slow and gradual. But perhaps only one or two rises will be needed or much more, they simply do not know.

Where does this leave Forward Guidance?

We are long past the stage where this policy of “open mouth operations” should stop and frankly Martin Weale should have voted for that at the last MPC meeting. After all it is quite plain that he no longer believes in interest-rates being lower for longer. In fact the very concept of Forward Guidance was of course misleading and it is getting worse. It was the last throw of the dice of a “maxed-out” policy regime.

What about Quantitative Easing?

If you are holding a large amount of UK Gilts then one of the last things you want to see are rises in the UK base rate as these are historically associated with Gilt price falls and yield rises. As the Bank of England is the largest holder of UK Gilts via its £375 billion of Quantitative Easing this leaves it with quite a headache. Regular readers will be aware that I have been making the case for not rolling over individual bond maturities for a year or so now. This would not wipe out the problem but it would at least get us on the road. Sadly the official policy is to often buy ultra-long Gilts instead, in a policy that looks designed to maximise rather than minimise the likely losses. For example the Bank of England owns over £7 billion of a Gilt which matures in 2060.

This area does not get much publicity and it is my opinion that this is deliberate. After all the terms of office of those involved are likely to be over before the full-scale of any capital losses are ever announced. This is in marked contrast to the interest-rate gains (we are paying coupons in effect to ourselves) which are now squirreled away as soon as they happen.

What about inflation?

As Martin’s job is supposed to involve keeping the official UK consumer inflation rate as near to 2% as possible there is a clear problem. Whilst the annual rate nudged up to 1.8% in April, Martin was on an MPC which sat on its hands and did nothing when inflation pushed above 5% back in 2011. So 5% inflation can be ignored but 1.8% cannot?

Of course just as important is the issue of where we think that inflation will go next. Unfortunately for Martin he is part of a body which issued this Inflation Report just over a fortnight ago.

Inflation has been near to the target in recent months, and is expected to remain at, or a little below, 2% throughout the forecast period.

Institutionalised Inflation

Perhaps Martin Weale is thinking of this category to which we discovered yesterday we can add one more to the list. The London Congestion Charge is to rise from £10 per day to £11.50 which this morning has been justified on LBC radio by London Mayor Boris Johnson on the basis “it was in line with inflation”. If we look at the official inflation rate it has in fact risen by just under 10%.

Mind you he was not alone in have problems number-crunching. From the Federation of Small Businesses via the BBC.

Londoners deserve a grown up debate about the merits of the current scheme in operation which is why an 11.5% increase is a regressive step.

What about the value of the pound?

This is an issue that Martin Weale’s interview appears to have missed. Even with the recent dip to US $1.67 the rise in the value of the pound’s exchange-rate is worth nine of the 0.25% rises in base rate that he discusses. It has had a strong dis-inflationary effect without so far having too much impact on output in something of a nice double act for the UK economy.

If we look forwards what troubles me is that a base rate rise now might give us an example of having too much of a good thing. Foreign exchange markets are likely to see a rise as the beginning of a sequence which could push the value of the pound higher. We have been in an overshooting period before and it did us little good. So we have an irony for UK monetary policy which is that right now, it is a strong rather than a weak pound driving UK monetary policy.

In my view this position is exacerbated by uncertainty over what the European Central Bank will do next Thursday. So far in 2014 it has promised much but delivered little and it would be very helpful for UK policy if it made its move so we could see the impact on the value of the pound.

I have described today how Martin Weale is suffering from various types of intellectual confusion. This is not the first time either that he has dithered because he actually voted for a 0.25% base rate rise from January to July 2011 before putting his tail between his legs and changing his mind.

As for me the current situation was rather aptly described by the Rolling Stones some years ago.

You can’t always get what you want

In the early days of this blog I argued that we should nudge base rates (to~ 1.5%) to respond to the above target inflation that I (correctly) saw on the horizon. But we did not do that and as a matter of timing it could go very wrong if we raise them now and see the pound push higher. That mistake has been made before.

Small business lending

Meanwhile the Bank of England’s flagship Funding for Lending Scheme continues to struggle.

Bank lending to SME businesses was -£723 million in the first quarter of 2014 under Funding for Lending.

Even the best bit looks very expensive.

The bad news is that the extra £536 million of Lloyds SME business lending cost us £2 billion of #FLS funding!

they are not targeting CPI or RPI inflation rates but wage inflation …..

And they are not as “independant ” as they make out – theres an election to be won / lost on the outcome of an interest rate rise

I agree its been long overdue and like all useless middle management they are why behind the curve.

oh well – lets hope pop corn can follow the curve as toffee flavour seems to be too high ….;-)

Forbin

mickc

But interest rates to borrowers (if they can even get a loan) are not low.

Putting up interest rates will collapse the economy-similar to the Howe “oversqueeze” of the early 80s.

Forbin

the issue here is if the BoE raises the base rate – will it be passed onto consumers?

given that

1, as you state the mortgage loan rate is divorced from the BoE currently

2, other loan rates and credit card rates seem also to be in their own bubble

3, Even if it is coupled again , ie 0.5 goes to 1.0% , the rate of coupling will be , what for 0.5 rise or will they plump for a 1.0% rise onto the mortgage rate – stating they are building in a future safety factor ( and Arthur Dent would say ” who’s safety , yours or mine? ” )

4, What will HMG be paying ? Double the rate means…….???

Forbin

mickc

Oh, any rise will most certainly be passed onto the borrower!

There is no risk to the banks in doing so. They just blame the BoE for the problems created- and get bailed out again by the taxpayer if they look shakey.

therrawbuzzin

Indeed, without change in circumstances, new borrowing, or anything which might affect my credit rating, I received a letter from Santander two days ago, stating that it was raising the interest rate on my credit card by THREE PERCENT!
Bye-bye Santander credit card.

mickc

Many are not in a position to do so! So they are totally f***ed!

The resentment this is building politically isn’t understood by the Westminster and City elites.

Dump financial shares before the next election. Labour will win and the City will take a (well deserved) hiding.

Noo 2 Economics

Hi Shaun,

Why do you feel “open mouth operations” are a failure? Whilst they may have caused confusion when entered into by the IMF they seem to have worked well for the Fed, ECB and BOE.

For now, I’ll stick with the BOE as that is today’s topic. Without doing anything other than talking (open mouth operations) Carney has managed to talk up the GBP thereby reducing inflation (and somehow increasing exports!). I think this is actually an achievement, he has fooled most of the people most of the time and the UK is better for it.

I’m now becoming scared by Weale’s comments as I agree a base rate rise now will send the GBP sky high at which time it will be considered a “safe haven” by investors who will pile in and send it into the stratosphere which, will then be followed, with depressing predictability, by another bust, only this time there’s no money left to bail out the banks. Oh, I forgot there are always private savings via bail ins of course – remember Cyprus!

Anonymous

I think the BoE can only create space for political solutions, of which there have been none. By defying expectation Carney is playing with sentiment which, the further you stretch it, the faster the backlash.

The bottom line is the UK needs low rates unless there is systemic change. This change isn’t politically feasible without a crisis. Therefore there will be a crisis.

I’ve seen nothing to suggest the UK is in anything other than the eye of the storm. Mix in demographics and you have the perfect storm.

Anonymous

I agree pressure is building. But the establishment understand that without the shape-shifting City the UK will be unable to kick the can using fake accounting and will be insolvent.

This is what’s interesting. Cameron/Milliband can’t come out and say “we have to have huge immigration to shore up the support ratio for fake pension promises” and the boomers are clamoring for their own death warrant via UKIP. Similarly the end of the city will implode the UK, even if it is a cancerous nightmare. The UK is too far gone. The changes required are not politically possible. They will become possible when there is a huge systemic failure.

Anonymous

Hi Forbin

At the moment both official consumer inflation and wage inflation
give the Bank of England an excuse for “masterly inaction”. They will get a bit of time on this as April’s wage data will be influenced by last April’s surge where bonuses were shifted to miss the 50% income tax rate. That will likely buy a few more months…

The independence argument pretty much went when the Bank of England had to ask the Chancellor’s permission to undertake QE by buying Gilts. But should they wait until after the election to raise base rates then another nail will go into what is already a pretty full coffin lid!

Anonymous

Hi Mickc and welcome to my part of the blogosphere

As to the gap between official and actual interest-rates you are preaching to the converted as it was one of my earliest theme on here.

As to the problems of raising them then actually remain the same. It is always argued that a rise cannot be afforded by borrowers and will lead to economic collapse. As to the Howe “oversqueeze” he did shoot them up! Six months after being elected the MLR had gone from 12% to 17% in what feels like a completely different world now does it not?

Anonymous

Hi Noo2

If we think of this in the way of the Frenchman from the film the Matrix with his “cause and effect” I do not see any mechanism here. So Bank of England Forward Guidance offered lower interest-rates for longer when nobody expected them to rise anyway. Now we have moved into 2014 there have been some voices asking for a rise and futures markets have moved that way. So what has Forward Guidance achieved? Do we believe that people invested or took out mortgages believing this?

As to the currency as I have said with my “dark side” theory I do give Mark Carney credit for not following the “talk the £ down” mantra of Governor King. But did it rise because of his policies? I think that the return to economic growth which began before he turned up did that. So Mark Carney has been lucky which according to Napoleon is far from being all bad..

Eric

Hi Shaun, 25 bps would be a 50% rise. Why not 5 or 10 bps? If we are now on dangerous ground (timing wise) then why not start really small. And just because the rate starts to rise doesn’t mean it should automatically continue. We could end up at 1% for a couple of years (for example). Mark could even put that in his forward guidance – the policy I mean, not the 1%.

I’m just not sure about the “output gap” – it could very easily be a mirage caused by exceptionally loose monetary policy. Calling .5% an “emergency” rate was a mistake; it caused fear and doubt in the minds of nearly everybody – confidence remains low 5 years on.

Paul C

Progrock, decisive commentary as ever!

Indeed, I believe your broad ranging conclusion hits the
nails right on the head. The older cohort that are most likely the voters challenged by immigration. In addition to indulged/ignorant to realize that their wealth concentration is from occupying rubbish housing stock that is in very short supply and in addition rentier lifestyle adorned from commanding such “assets”.

I am entertained to think of Farage, referred to in Italy as “IL Clown” (I was there on Tuesday). What would he actually do if entrusted with the job, he is not dumb. I think he would adopt identical Con/Lib/Lab policies of ineffective border controls because as you say the
country is too desperate for a support ratio to pay pensions.

I agree regarding the city, despicable though their recent actions (last 10 years) are, there is nothing to replace this kind of £”value” of services export.

In an bizarre confluence of self-inflicted wounds and
antagonistic influences we cannot physically build the homes necessary to shelter the growing population because the construction skills/trades have been lost, by perverse counter, if we did build enough then that could topple high house prices. We don’t need to worry however because the same Boomer/Nimby brigade voting for Farage are voting against any new development anyway.

The perfect scenario is plainly evident: Immigrants should preferably not be here, however if they are then they must pay rent to boomers whilst working in care homes looking after the boomers, their PAYE taxation and consumption taxes can be harvested to service pensions promises to boomers. It is a perfect circle.

Regarding interest rates, there is no bigger rock or harder place that that created through the financial repression by concerted western governments. Rates simply cannot rise or there will be a catastrophe. Take a look at Gillian Tett’s article this evening in the FT, she is calling the order of the day.

Of course the economy is getting better we’ve got
growth don’t you know?

Noo 2 Economics

Yes, certainly the man in the street took out his mortgage believing the “lower for longer mantra” in spite of the evidence of loan rates drifting upwards, with the exception of HTB which of course can be used as the reason for more mortgages being taken out and fueling the recovery via rising house prices, which in turn lead to a “feel good factor” over the last 7 or 8 months.

I agree the recovery started as Carney arrived 10 months ago but it could have easily fizzled out towards the end of last year had he messed up on Forward Guidance. Sure, futures are expecting a rate increase as I have been since last November but I am discussing the man in the street who watches/reads/listens to msm and the only messages from the msm is “lower for longer”. As for investors, we usually do our own research so Forward Guidance was never going to work on us, but then I believe it was only ever aimed at the man in the street as it is he who will push the economy forward through spending slightly more and creating an increase in aggregate demand.

Obviously we are in disagreement but I will leave this thought – would the average person, having suffered below inflation wage rises over the last 6 years, have taken any kind of mortgage with expectations of having to pay more interest on their loan in the next 12 months?

Noo 2 Economics

Agreed, although it will take decades for the end to arrive and when it does, it may lead to a new beginning. Meantime they will try to increase rates slowly over the next 2 – 3 years if for no other reason then to build policy space.

The base rate has become meaningless to all except the banks as Shaun says the actual borrowing rate used as a reference is circa 2.75% due to bond futures movements which then of course has a premium added to ensure profitability before being retailed.

mickc

Whilst believing the outlook is grim, the substance can be fixed.
The UKhas to be weaned off house prices as the growth area- more have to be built as all political paries now agree. This will be done despite the nimbys.
Investment in manufacture must be prioritised, not yet the policy of all, but Labour will prob do so in their manifesto.
The banks have to be controlled (think Thatcher/unions) ans again Labour will prob do this.
And Labour will prob win the next election, so a start will be made.
The giraffe is, i’m a paid up Tory but they are clueless!

Anonymous

Will the city take a hiding from Labour ?

Tony B didn’t hurt the city. So the next Labour leader (whatever the timescale) might also be more interested in their own “ascent to heaven” with a post-politics highly paid bank job.

Anonymous

It wouldn’t because nobody borrows at the base rate.

Anonymous

Hi, not sure which Tett article you mean. Was the title “Tranquil markets are enjoying too much of a good thing”?

Eric

I don’t understand pogrock. What wouldn’t?
I’m clumsily saying because the rate is currently .5% then any rises could be in smaller increments than .25% per quarter . The rate could be nudged up (to quote Shaun) not hiked up.

I’m not making any assumptions about what rates of interest people borrow at; although I guess when the base rate does start to rise bank mortgage rates will rise faster than savings rates.

Anonymous

Sorry it was a terse reply. I mean that as nobody actually borrows at the base rate a 0.5% increase, although a 100% increase on the base rate, would be a significant but smaller % rise on loans the public can get at 4% or whatever it is nowadays.

I’m sure you are correct that saving rate rises will lag mortgage rate rises. However I think they won’t raise rates until forced by the US. Plus the UK can’t raise rates as we have a hollowed out turd of an economy.

Eric

Hah, thanks. When I wrote the first comment I had it in mind that when the MPC finally decides the time is right to start to raise rates they would not want to frighten all the king’s men and all the king’s horses. Just think of the effect on the £ if Carney’s “guidance” suddenly implied that the rate would be 1% higher by this time next year.

The MPC really have painted themselves into a corner.
Trapped by a hollowed out turd indeed!

Eric

I don’t think savers who are receiving very low returns on money in the bank regard the base rate as meaningless.

Paul C

That’s right, for all the media would have you believe about a recovery there are those that recognise that this may be a temporary period of tranquility, not a truly reflective position of resolved issues.

therrawbuzzin

“Ascent to heaven.” brilliant!

Shaun Richards is an independent economist who studied originally at the LSE. His speciality is monetary economics and he uses it to analyse current economic trends. He started his career in the City of London in 1985 and brings his trading experience in bond, currency and derivative markets to his analysis of current economic events. Follow him on twitter @notayesmansecon.